Borrowing money has rarely been cheaper, as interest rates are close to their lowest levels of the last 10 years. That might mean that getting a personal loan makes a lot of sense to help you achieve one or more of your financial goals.
But even if you’re considering applying for a loan, it’s easy to get overwhelmed by some of the jargon that gets thrown around on the websites of banks and other lenders. To help you find your way, here’s a beginner’s primer on the terms, details, and other key facts about personal loans.
The length of time you hold the loan is called the term. The amount you borrow on a personal loan is called the principal. When you begin paying back your loan, you’ll also pay an additional amount that represents a small percentage of the principal amount. This is the interest rate – it’s how banks make a profit by lending you money.
Interest rates can be either fixed or variable. Fixed rates lock in a set percentage for the term of the loan, which is often from two to five years. A variable rate changes when other interest rates change (for example, when the cost for the bank’s own borrowing goes up or if the Federal Reserve raises or lowers interest rates). Most personal loans, however, have fixed rates.
You may also see a reference to the annual percentage rate, or APR. This is an easy apples-to-apples way of comparing interest rates across borrowers. It’s the annual rate that is charged on the loan’s principal amount that expresses the actual yearly interest rate cost of the loan, plus fees or additional costs (the interest rate by itself does not include fees or additional costs). Banks and other lenders are required by law to show customers the APR they’ll be charged.
Types of Loans
There are generally two types of loans – secured and unsecured. A secured loan is acquired by pledging an asset of yours, such as a car, property, or a savings account as collateral. By using a secured loan, you can often get a lower interest rate since, because from the bank’s point of view, you have a tangible asset that would cover the loan debt in case you fail to repay.
Unsecured loans have no collateral to back them up, so you’ll likely pay a higher interest rate than you would for a secured loan. Most lenders will look at your credit score (find out your credit score for free at MoneyLion) to determine whether giving you a loan is a good risk.
When a Personal Loan Might Be a Good Idea
A personal loan could make sense when it’s your lowest-cost option to get money that allows you to pay for something that you can’t buy outright immediately – or when it saves you money in the future. That’s why using a loan to pay off -- or consolidate -- some of your debt is one of the most common uses for a personal loan. Here’s a quick example: If you get a personal loan with an APR of 7 percent to pay off a credit card with an APR of 10 percent on a revolving balance, you could save yourself thousands of dollars in interest costs.
But many people also use personal loans to pay for home improvement projects, to cover school supplies – or even to pay for weddings or vacations. The key is that the loan shouldn’t make your financial standing worse over the long term by becoming just another debt that you can’t pay back.
When You Should Be Wary About Getting a Personal Loan
A personal loan isn’t always the best option to increase your financial reach. If your credit is in good standing, for example, you may be able to qualify for a credit card that offers you a zero percent interest rate for 12 months or even longer.
If your credit is on the borderline, be aware that applying for a loan can trigger what’s called a “hard inquiry” into your credit score – this can lower your score (to learn more about your credit score, read our “What's my credit score? Why it's critical to know this three-digit number” post), affecting the interest rate you might be able to get for a loan. Also, always be mindful about applying for too many loans, which can also lower your credit score. For tips on how you can improve your credit score, see our “5 easy ways to help raise your credit score” post.
Most importantly, make sure you can pay off your loan over the entire term. Because unsecured loans aren’t backed by any property, your inability to pay back the loan could subject you to legal action.
Our Shameless Plug!
Now that you have the basics down, keep MoneyLion in mind if you’re ever looking for a personal loan option. You can apply online in minutes. Our rates are competitive, are unsecured (no collateral necessary), and if you’re approved you can get your money as soon as next business day. Best of all we provide free tools like credit monitoring, personal financial management tools, and rewards so that you can achieve financial wellness.